How to calculate discount points in real estate

What are Discount Points on a Mortgage?

Discount points are a form of prepaid interest that borrowers can purchase to lower the interest rate on their mortgage loan. One point typically costs 1% of the total loan amount and can reduce the loan's interest rate by a predetermined amount. Buying discount points is an upfront payment in exchange for a lower interest rate, which can lead to significant savings over the life of the loan for those who plan to stay in their home for a long time.

How to Calculate Discount Points on a Mortgage

Discount points in real estate are essentially prepaid interest on a mortgage loan. Here's how to calculate them:

1. Understand What a Point Represents: One discount point typically equals 1% of the mortgage amount. For instance, one point on a $200,000 mortgage would cost $2,000.
2. Determine the Number of Points: The number of points you'll pay depends on your lender and the current market conditions. Sometimes, lenders may charge fractions of a point.
3. Calculate the Cost of Points: To calculate the cost of the points, multiply the number of points by the loan amount. For example, if you're paying 2 points on a $200,000 loan, it would be 2% of $200,000, which equals $4,000.
4. Understand the Trade-off: Typically, the more points you pay upfront, the lower your interest rate. This can save you money over the life of the loan if you plan to stay in your home for a long time.
5. Consider the Break-Even Point: Calculate how long it will take for your monthly savings from the lower interest rate to exceed the cost of the points. This is your break-even point, and it helps to determine if paying points makes financial sense.
6. Consult with Professionals: It's often helpful to talk to a financial advisor or mortgage professional to understand how discount points would affect your specific financial situation.

Remember, the decision to buy discount points should be based on your financial situation, how long you plan to stay in the home, and how much you can afford to pay upfront.